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Chazen International Study Tour Report
Real Estate in London and Berlin
Michael Ferry MBA ’06
Edward Martell MBA ’06
Jeff Remillard MBA ’06
Sponsored by The Heinz Dürr International Communications Fund
© 2006 by The Trustees of Columbia University in the City of New York. All rights reserved
CHAZEN WEB JOURNAL OF INTERNATIONAL BUSINESS
www.gsb.columbia.edu/chazen/webjournal
A Note from the Authors
The growing prominence of capital markets in today’s real estate industry has led to
greater investor focus on global real estate opportunities. The trend is manifested through
increased economic sophistication of real estate entities and growing capital flows for
international investment and development. To explore these themes, Christopher Mayer,
the Paul Milstein Professor of Real Estate and director of the MBA Real Estate Program and
the Paul Milstein Center for Real Estate at Columbia Business School; Cheryl Carruthers,
associate director of the Milstein Center; Camille Douglas, former CFO of Canary Wharf;
and 25 students took part in a real estate tour of London and Berlin to gain further
understanding of these markets. From March 3 to 13, 2005, we spent five days in each city
and met with executives of brokerage houses, investment firms, development companies
and opportunity funds to understand the investment opportunities in and capital flows
through and these two core European real estate markets.
Chazen International Study Tours
Designed to enhance the classroom curriculum, Chazen International Study Tours offer
students and their faculty adviser an intense, firsthand experience of the business culture of
their chosen country or region. Study tours are initiated by students and organized with the
help of the Jerome A. Chazen Institute of International Business. During study tours
students meet with leading executives and government officials while visiting businesses,
factories and cultural sites. Recent destinations include China, France, India, Japan, Russia
and Scandinavia.
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Overview of the United Kingdom Real Estate Market
Our initial view of the UK real estate market revealed a setting surprisingly similar to its counterpart in the
United States: an abundant amount of capital chases a few deals, which results in price increases and lower
cap rates. In addition, much of this capital comes from international sources. According to DTZ Research, in
2004 cross-border purchases accounted for about one third of real estate acquisitions in the United
Kingdom. Of these international capital sources, the United States was the largest, contributing $13.5 billion.
Retail and residential assets are the major focus of increased investment. However, the fundamentals of the
office-space market are not as robust, as the United Kingdom has experienced a few years of slower job
growth, which has hurt demand for office space. Currently, office-vacancy rates are high (up to 16 percent
in London’s city market), there is pressure on rental rates and concessions are often granted in order to rent
space. However, signs of improvement on the horizon combined with low interest rates and abundant
amounts of capital have maintained interest in the sector.
A second source of capital comes from the pension system. After the equity bubble burst in 2000,
investors viewed real estate more favorably for its steady returns and transparent cash flows. After
sustaining heavy losses in the stock market, more investors have concluded that real estate should be
included in retirement funds. This has led to an increased amount of capital in the system. However, this
capital is no longer chasing single-asset deals as in the past. It is now focusing more on investing in
specialized funds, similar to the United States, where a pension plan might place a certain percentage of its
real estate allocation in an investment fund focusing on value-added retail purchases and another portion in
a fund that focuses on core office properties.
UK Property Investment: Current Trends
The investment market has been strong in the United Kingdom given the significant capital inflows
discussed above. Retail has stood out over the past few years. Despite a slower-growing economy,
consumer demand has held up, which has supported fundamentals in the sector. This, combined with an
increased amount of capital chasing deals, has boded well for investments in the sector.
Investments related to housing have also done quite well in the recent past. Of note, however, is the
lack of an institutional multifamily housing sector. Multifamily investments are stable, sought-after purchases
for U.S. institutional investors, but large multifamily complexes where an institutional owner could buy a
property and take advantage of economies of scale are virtually nonexistent in London and other
UK markets. Many of the investments made in the multifamily market are small, private buyers purchasing a
few units in multiple locations and renting them out. However, according to Credit Suisse First Boston
(CSFB), the development of a more institutional multifamily market could emerge in the future.
The commercial office market has also performed well over the past few years. Yet, as noted above,
the performance was driven more by increased amounts of capital than by improving fundamentals. Wellleased, Class A office space demands a premium in the market. One reason for this is the structure of office
leases in the United Kingdom: they typically run for 20–25 years and have upward-only clauses. Therefore,
if an investor purchases a well-leased property, he or she is essentially buying a tangible asset with an
almost bondlike quality, which is very attractive to certain investors. According to British Land, city offices
are not meeting their pro forma 7.7–10 percent unleveraged returns. However, London is an international
economic powerhouse and very important in the financial world. Therefore, there will always be a strong
demand for office space in the city, which will keep investor interest in the sector high.
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According to Ian Marcus of CSFB, one of the areas presenting a potentially robust opportunity in the
near future is the sale-leaseback market. The United Kingdom has one of the highest owner-occupier
percentages (greater than 85 percent). Corporations should not be holding real estate, as it cannot generate
as high a return as reinvesting in their primary lines of business. This presents great opportunities for
investors to buy properties from corporations divesting their real estate and lease it back to the
corporations. According to Marcus, this market could develop even further should corporations decide they
want to participate in some of the upside of their real estate by forming joint ventures with property
owners rather than just unloading 100 percent of their property.
UK Real Estate Development: Current Trends
Given the strong fundamentals, well-located retail and housing development in the United Kingdom
remains attractive. The real question about development revolves around adding office space. As was stated
previously, office-market fundamentals are not overly strong at the moment, but development of office
space can still be attractive in cities such as London.
To begin with, there is not a lot of developable land left in London. This shortage, combined with the
importance of London in the international economy, makes office development appealing. In addition, the
London office market is characterized by old buildings with strange layouts and small floor plates, whereas
the financial services industry—a driver of the London economy—demands large floor plates and open
space that can accommodate trading floors similar to those found in the United States. As a result, there are
opportunities for redevelopment of certain buildings within the city of London. More important, this need
for large floor plates led to the creation of Canary Wharf.
We were fortunate enough to spend time at Canary Wharf, both touring the property and meeting with
Peter Anderson, Canary Wharf finance director. Development at Canary Wharf began in 1980 when the
London Docklands Development Corporation was created to improve the use of the land. Olympia & York
eventually took control of the land and began fulfilling the need for the new type of office product in
London—larger, more open floor plates for financial services firms. Today, Canary Wharf consists of
approximately 9.9 million square feet of office and retail space that is more than 86 percent occupied, with
rental rates that are lower than those in other high-end London markets.
UK REIT Legislation Update
The United Kingdom is currently considering introducing a REIT structure similar to that in the United
States. Both investment banks such as Morgan Stanley and CSFB and large public property companies such
as British Land are anxiously awaiting the arrival of such a vehicle, which will have a great impact on the
market. Analysts from Morgan Stanley believe the introduction of a REIT structure in the United Kingdom
could compress cap rates by nearly 150 basis points given the transparency this vehicle could lend to the
market. It is hopeful that a REIT structure will be in the market by 2006. If it is not, industry insiders feel
this will cause local property companies to seek listings on exchanges outside the United Kingdom.
Overview of the German Real Estate Market
Germany was one of few industrialized nations to escape the economic challenges of the early 1990s. Much
of the country’s steady growth in that decade was subsidized by massive government investment to unify
East and West Germany. Since reunification, Berlin has served the nation and the world as a symbol of the
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new German unity. The German government relocated to Berlin from Bonn in 1999, a process that cost
$11 billion dollars and helped to spur investment in the city’s property market.
In recent years, Germany has struggled to recover from its expansive zeal of the 1990s. Unemployment
has topped 17 percent in Berlin and nearly 11 percent nationwide. Real GDP growth has been negative,
although initial reports for 2004 look more positive, with GDP at 1.7 percent real-term growth.
Berlin Market: Current Trends
The Berlin property market mirrors the rise, fall and current struggle for growth that Germany is
undergoing.
Berlin’s main challenges are oversupply in all sectors and paucity of employment opportunities.
Oversupply due to the building boom has caused office vacancy rates to increase since 2000 to
approximately 11 percent in 1Q2005. Berlin is Germany’s largest office market, with 18 million square
meters of lettable space. A cause for optimism in the market is the dwindling volume of new supply, which
is expected to be less than 100,000 square meters in 2005, down from an average of 400,000 square meters
between 2000 and 2004. Much of the letting activity in 2004 was driven by businesses relocating to betterquality spaces throughout the city. Because of the slow market, yields on office properties have shown
signs of decreasing.
Berlin is resplendent with architectural masterpieces by such luminaries as Renzo Piano, Richard Rogers
and Christoph Kohlbecker. The Sony Center at the new Potsdamer Platz, which was developed by Tishman
Speyer, earned more from development fees than in return on equity. Projects such as this literally cover
the painful relics of Nazism and Communist occupation with postcard-quality Class A space, but
architecture alone can not lure new industries to Berlin.
The Anschutz Group’s Media Spree development is designed to attract media companies to Berlin.
Marketing points of the project include an affiliation with Berlin’s creative heritage and its young, selfdesignated “wild” population. The project developers are willing to build loft-style spaces with irregular
floor plates in a bid to attract edgier tenants.
Media Spree is located along the banks of the River Spree in East Berlin. Although new construction
has nearly stopped due to the supply glut, Paul Abeler, director of investor relations, predicts a total
development size of 1.8 million square feet to be completed over the next 20–25 years. The group will
break ground on a new building once it reaches a prelease commitment of 60–70 percent (down from 20–
30 percent in the mid-1990s). Average leasing commitments are 5–10 years, and rental rates range from
€5 to €10/square meter.
Because many German industries entrenched themselves in the free West after World War II, Berlin has
found luring them back to be nearly impossible. For example, Frankfurt has been and remains Germany’s
center of finance. Today, its market for Class A office space is one of few sectors that are considered
attractive by national and international core investors.
Currently, international opportunity funds are overlooking short-term economic hurdles to focus on
perceived supply-and-demand strengths. At approximately 30 percent, home ownership in Germany is low
compared to international peers. Morgan Stanley Real Estate Fund (MSREF) has recently purchased 48,000
apartment units from industrial conglomerate Thyssen-Krupp at €570/square meter in hopes it can resell
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them to individuals for €800/square meter. MSREF’s move into German residential markets is considered
peculiar by local investors who are endeavoring to diversify their portfolios away from German exposure.
Deka Immobilien, a German open-ended real estate fund manager, believes that local, well-leased
property is overpriced and high vacancy properties are too risky for its investors, many of whom are retail
investors. The fund, like many of its competitors in the €80 billion market, is taking advantage of recent
legislation that allows it to invest overseas.
Eastern Europe: Current Trends
As cap rates continue to compress in the United Kingdom and Western Europe, investors and developers
have chased yields across the European Union to Central and Eastern Europe. Institutional investors,
opportunity funds and international developers are spreading the flow of global capital into new countries,
many of which are still struggling to escape the legacy of Communist rule.
Investors who can successfully navigate potential obstacles will benefit from strong market supply-anddemand fundamentals. A dearth of modern building stock will ensure success as countries such as Poland,
the Czech Republic, Hungary and Croatia, among many others, integrate into or prepare to join the
European Union. Best-in-breed global property developers are well positioned to partner with local experts
to replenish outdated Communist-era housing, office and industrial assets.
Hines, a Houston-based global fee developer, planted its flag in Europe in the early 1990s. The firm’s
London office manages two Western Europe development funds totaling over $600 million in investment
and also oversees European investments for two U.S. funds whose global focus includes Eastern Europe as
well as Asia and South America. Hines’s success in Eastern Europe has been mixed. Mark Sears, managing
director, cites as barriers to success a lack of cleanly titled sites and of sophisticated local partners, murky
zoning laws that handicap private investment and small deal size. At present, Hines has redirected many of
its resources to projects in more transparent markets such as Italy and France.
Potential investors in new European markets are most concerned with a country’s prospects for
admission to the European Union. AIG/Lincoln’s European joint venture has overseen $875 million of
investment since its inception in 1997. The AIG/Lincoln development fund applies the classic Trammell
Crow development model to Eastern European markets. First, the firm assesses new opportunities by
examining national GDP level and growth, political stability, strength of competitors, insurability of assets,
existence of local finance institutions, willingness of lenders to finance deals and good returns. If a market
passes the requisite analytical hurdles, AIG/Lincoln invests up to $2 million in overhead to establish a
regional office and build a staff of nationals with local development expertise. Once a local office is open,
the fund can begin to source and develop projects.
The AIG/Lincoln approach combines global capital and local expertise in what many experts believe is
the best way to capitalize on new markets, cycles and property types. Investment in new markets is made
possible by increased government deregulation, harmonization of participant interests and availability of
information. Such trends will promote ownership among local populations and provide a valuable source
of portfolio diversity for international investors. Promising sectors to watch include Turkey, whose
candidacy for admission to the European Union should be bolstered by its large and young workforce, and
Russia, which is experiencing tremendous growth from oil wealth.
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Conclusion
Our academic intent was to study the real estate markets in and capital flows and through London (as a
potential center of the world economy) and Berlin (as a gateway to Eastern Europe). The trend of global
real estate development and investment was apparent during our trip, both through meetings and tours
with local sharpshooters as well as with global developers and investors. Depending on their risk tolerance
and yield requirements, the opportunities and strategies of the different firms with whose executives we
met were vast.
London’s more established economy and access to capital markets make it a more predictable and well
defined market.
Berlin, with its massive oversupply and weakened economy, remains more questionable. When the
wall fell in 1989, many firms focused there with hopes of massive growth. But growth remains well below
expectations, resulting in low prices and tremendous longer-term opportunity.
Both cities, however, remain centers of European real estate—London as a more central location, and
Berlin as a gateway to Eastern Europe and future opportunity.
We expect access to capital markets to permit continued growth in global real estate markets. However,
sustainable global growth will require the identification or development of sophisticated local partners to
provide the transparency and efficiency upon which the capital markets thrive. As local partners seek new,
international financing sources and investors pursue new opportunities for portfolio diversification and
enhanced returns, we will expect a continued increase in the number of international joint ventures, growth
of transparency and expansion of global real estate capital markets.
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